Tax relief on property finance costs - interaction with savings and dividend income

[tg99]

The tax reduction for landlords of residential properties now that finance costs are no longer deductible against gross property income is calculated as the basic rate value (currently 20%) of the lower of:

1. finance costs - costs not deducted from rental income in the tax year (this will be a proportion of finance costs for the transitional years) plus any finance costs brought forward

2. property business profits - the profits of the property business in the tax year (after using any brought forward losses)

3. adjusted total income - the income (after losses and reliefs, and excluding savings and dividends income) that exceeds your personal allowance

So, assume we are in 2020-21 (I.e. when the four year phase in completes) - and you have say no employment or pension income, £7k savings income, £12k dividend income, £1k other income, £16k gross rental income. And your property rental costs are £10k finance costs and £6k non finance costs. Assume personal allowance (PA) is £13k.

Hence the figures for 1, 2 and 3 above would be 1. £10k 2. £10k 3. £0 (as property profit of £10k plus £1k of other income does not exceed PA of £13k). Hence no tax deduction would be applicable since 20% of the lowest of these figures is 20% of zero. (Though the therefore unused £10k finance costs can be carried forward to use in future years.)

So, is there a way you can rearrange the order of your income when using your personal allowance such that you fill it first with the savings and dividend income (once allowed for the allowances here) such that it is then your property income that is exceeding the personal allowance threshold thus making the tax reduction applicable?

I am assuming not but just want to double check as I did read something a while ago (not related to property though) about how the taxpayer can choose how to order their use of earned income, savings income, dividend income and hence this is one of the reasons why for some taxpayers the self assessment HMRC online calculator was calculating too much tax because it wasn’t taking into account the ability to change the order.

[someone]

I'm probably talking bollocks but doesn't the new regime actually (potentially) help in this case?

Old way : 16K income offset by 16K (finance plus non finance) meaning no gain or loss and most of the personal allowance unused.

New way : 16K income offset by 6K (non finance) meaning 10K to use up annual allowance.

2K of tax relief due to finance costs unused and can be carried forwards until there is some tax to pay.


I can't quite work out what you want to achieve.

[AdamS93]

You are correct.

In a tax year, relief at 20% is only available on the lower of the three you have mentioned - adjusted total income being net income less the personal allowance less savings and dividend income.

The objective of this is to prevent the basic rate tax relief for mortgage interest being offset against other tax liabilities for dividends/interest.

As I have been telling people, HMRC are coming after BTL landlords and I think there will be further tax implications for residential properties held in limited companies. I am no financial adviser, but currently I wouldn't invest in residential property (unless you don't need a mortgage) especially with interest rates only going one way, which will really hurt with the restriction for the tax relief coming in.

Ideally you need to turn the dividends in to a salary if the dividends are from the individuals company.

[tg99]

Under the ‘old way’ most of the PA would go unused as you say and hence no tax would be due.

Under the ‘new way’ the property profit of £10k plus the £1k of other income means there would be £2k left of the PA before savings and dividend income. £5k of the savings income would be covered by the zero percent band and £1k by the basic rate tax free allowance. Thus leaving £1k of savings income as taxable. £2k of the dividend income would be covered by the dividend allowance thus leaving £10k dividends taxable. Hence using up the remainder of the PA would then leave £9k dividends taxable at 7.5% so £675. There would be no 20% tax reduction from the finance costs as my adjusted total income before savings and dividends would not exceed the PA (albeit the £10k finance costs could then be carried forward for future years).

However, if the taxpayer was allowed to order their different types of income as they desire then you could first allocate the £1k of taxable savings income and the £10k of dividend taxable to the PA leaving £2k PA remaining. Then allocate £1k other income plus £10k property profits thus meaning total income now exceeds PA by £9k taxable at 20% gives £1,800. The 20% tax reduction from finance costs would then be 20% of £9k thus giving £1,800 so overall the tax due would be zero.

Hence the point of my post is whether a taxpayer can choose the order of different types of income to allocate to his or her personal allowance in the way I have suggested in the paragraph above. I don’t think they can, plus I think it looks like it would still not be correct to work out the tax reduction as £1,800 as the guidance in point 3. of my opening post specifically says excluding dividend and savings income. However, I just want to double check incase my understanding is wrong.

[tg99]

That tallies with what I thought AdamS93 (had not seen your reply when I did my post just above as was still typing it up!). The ability to carry forward unused finance costs is not likely to be particularly useful in the above case either I don’t think as point 3. is always likely to be the lower figure of 1., 2. and 3. in future years.